What is a Cash Balance Plan?

Think of retirement accounts in two main categories: defined contribution and defined benefit.

• Defined contribution plans are the ones you’re probably familiar with, like 401(k)s and 403(b)s. You contribute, and your balance depends on contributions and investment performance.
• Defined benefit plans are more like traditional pension plans, where your payout is determined by a formula based on salary and years of service.

A Cash Balance Plan is a bit of a hybrid, blending elements of both. It’s essentially setting up a pension plan for yourself, but with some 401(k)-like features. It’s a separate account in addition to your existing retirement plans, offering significant tax benefits.

Three Questions That Sparked This Guide

This guide was inspired by questions from people just like you, seeking clarity on Cash Balance Plans. Here are the questions we’ll tackle:

1. “Please elaborate on a Cash Balance Plan for 1099 workers.”
2. “What is the 1099 income threshold that makes sense to pursue a Cash Balance Plan?”
3. “Mega backdoor Roth for 1099 income versus the Cash Balance Plan?”

We’ll dive into these questions and more to give you a complete picture of Cash Balance Plans.

Who is a Cash Balance Plan For?

Cash balance plans are primarily for high-income earners. If you fall into one of these categories, it might be time to take a closer look:

• Physicians
• Dentists
• High-earning professionals with substantial 1099 income

As a general rule, if you’re bringing in over $100,000 to $150,000 in 1099 income, a Cash Balance Plan could be worth considering. Why? Because the fees associated with the plan can eat into the benefits if your income is too low.

Also, if you own a dental or medical practice, you can set up these plans for yourself and your employees.

Advantages of Setting Up a Cash Balance Plan as a Practice Owner

Setting up a Cash Balance Plan for your practice can offer a trifecta of benefits:

• Tax Savings: You’ll get significant tax deductions for both you and your practice.
• Employee Retention: Offering a robust retirement plan can help you attract and retain top-notch employees.
• Employee Morale: Good benefits boost morale and create a happier workplace.

Offering a defined benefit plan can be a great way to show your employees you care. Plus, a Cash Balance Plan offers considerable tax savings that can help the practice thrive!

Before Considering a Cash Balance Plan: Maximize Your 401(k)

Before you jump into a Cash Balance Plan, make sure you’re fully taking advantage of your current 401(k) plan. You might be surprised at how many people aren’t maximizing their 401(k) contributions.

Here are the numbers to keep in mind (for 2025, but be sure to check the current year’s limits):

• Employee contribution limit: $23,500
• Total contribution limit (including employer contributions): $70,000

Are you only contributing $23,500? Then you might need to revamp your plan to take advantage of profit sharing to reach that full $70,000 limit.

If you’re a practice owner, team up with a financial advisor to design a plan that tilts the benefits in your favor through profit sharing and other features.

Mega Backdoor Roth vs. Cash Balance Plan

So, how do you choose between a Mega Backdoor Roth and a Cash Balance Plan? It boils down to your beliefs about future tax rates.

• Mega Backdoor Roth: You pay taxes now, but your future withdrawals are tax-free. This makes sense if you think tax rates will be higher in the future.
• Cash Balance Plan: You defer taxes until retirement. If you believe tax rates will be lower in the future, this could be the better option.

If you’re really ambitious, you can do both!

Contribute to your 401(k) pre-tax, use a Mega Backdoor Roth, and also contribute to a Cash Balance plan. It all depends on your cash flow and how much you can comfortably save.

The Mega Backdoor Roth Strategy

Here’s how the Mega Backdoor Roth strategy works:

1. Contribute the employee portion to a 401(k) pre-tax.
2. Make additional after-tax contributions up to the $70,000 limit (check current year limits, this is 2025’s #).
3. Convert those after-tax contributions to a Roth account (the “Mega Backdoor”).
4. Simultaneously contribute to a Cash Balance Plan pre-tax.

It’s a powerful strategy if you have the funds to make it happen.

Don’t Forget Taxable Brokerage Accounts

Even with all the fancy tax-advantaged accounts out there, don’t forget about the plain old taxable brokerage account. It still has a place in a well-rounded financial plan.

Here’s why:

• No contribution limits: You can save as much as you want.
• Tax-efficient management: You can minimize taxes through strategic investing.
• Flexibility: You can access your funds before retirement (though with potential tax implications).

If you’re already maxing out all your other retirement accounts or you want more control over your investments, a taxable brokerage account is a solid choice. You won’t get upfront tax savings, but long-term capital gains rates can be lower than ordinary income tax rates.

Tax Savings with a Cash Balance Plan: An Example

Let’s see how a Cash Balance Plan can save you money on your taxes.

Imagine you’re in the 37% federal tax bracket. You contribute $100,000 to a Cash Balance Plan. That reduces your tax bill by $37,000 in that year. Not bad, right?

If you live in a high-income tax state like California, the savings could be even greater, potentially up to 50%.

Just remember that you’ll eventually have to pay taxes on those savings when you withdraw the money in retirement. But with careful planning, you can minimize that future tax burden.

Good Uses of Cash Balance Plans

The best use of a Cash Balance Plan is to maximize retirement savings for high-income earners. But make sure you’ve fully utilized all other retirement savings options first!

Cash Balance Plans are Based on Funding Limits

Keep in mind that Cash Balance Plans have total funding limits.

The IRS limit is around $3.5 million (but be sure to confirm the current limit). Think of it as roughly a 10-year funding window.

The IRS uses the term “several years,” which means you need to be prepared to commit to consistent funding.

Preparing for a Multi-Year Commitment

A Cash Balance Plan isn’t a one-and-done deal. You should expect to contribute year after year for multiple years.

Each year, an actuary will calculate a contribution range for you. Be ready to consistently contribute within that range.

The Actuary’s Role

The actuary plays a key role in determining how much you can contribute each year.

They’ll provide a range, like $80,000 to $120,000 (just an example). Your goal is to find a sweet spot and spread your contributions out over as many years as possible.

“Usual” Fees Associated with Cash Balance Plans

What about the costs? Here’s a breakdown of the fees you can expect:

• Initial Setup Fee: Around $2,000
• Annual Fees: Approximately $3,000

*These fees can vary WIDELY from what is listed here.

These fees cover things like:

• Ongoing documentation
• Actuarial calculations
• Plan administration

Consider these fees when deciding if a Cash Balance Plan makes sense for you.

Threshold Considerations: Is It Worth the Cost?

Let’s tie those fees back to the income threshold question.

If you’re only contributing a small amount each year (say, $10,000 to $20,000), the fees might outweigh the benefits. But if you’re contributing a larger amount (like $100,000 or more), the tax savings can easily justify the cost.

Contribution Disparities in Practice-Wide Plans

If you set up a Cash Balance Plan for your entire practice, keep in mind that contribution amounts can vary widely among employees.

This is because contribution amounts are based on factors like age and income.

For example, a 35-year-old partner might only be able to contribute $75,000, while a 65-year-old partner could contribute $150,000.

Timing Contributions with High-Earning Years

Ideally, you want to time your contributions to coincide with your highest-earning years. This isn’t always possible, but it’s a good goal to strive for.

Investment Control: What to Expect

Here’s something that often surprises people: you don’t control the investments within the Cash Balance Plan.

The investments are managed to maintain a steady rate of return, typically around 3-5%.

This means you’ll likely see a conservative portfolio with a significant allocation to bonds rather than high-flying, aggressive stocks.

The goal is to achieve a guaranteed rate of return, and Cash Balance Plans don’t like volatility.

The Problem With Aggressive Investments

Why is controlling volatility so important? If your investments are too aggressive and perform exceptionally well, you could hit the maximum funding limit sooner than expected. The idea isn’t necessarily rapid growth but rather consistent income tax deductions year after year.

The Importance of Customization

It’s essential to work with a professional who really understands Cash Balance Plans. These plans are complex, and a qualified advisor can help you:

• Design a plan that fits your specific needs
• Navigate the complexities of the plan
• Ensure compliance with IRS regulations

Even when you’re working with professionals, take the time to understand how the plan works.

The Team Behind the Plan

Setting up and managing a Cash Balance Plan involves a team of experts, including:

• Third-party administrators (TPAs)
• Investment teams
• Actuaries
• Your existing 401(k) provider

This collaborative approach helps to keep the plan running smoothly and justifies the annual fees.

Key Takeaways: Is a Cash Balance Plan Right for You?

Let’s recap the key benefits of a Cash Balance Plan for high-income earners:

• Significant tax savings
• Opportunity to turbocharge retirement savings

Remember to:

• Understand the commitment involved
• Maximize other retirement savings options first
• Work with qualified professionals

A Cash Balance Plan can be a powerful tool, especially if you’re a high-income earner with substantial 1099 income. Just be sure to understand all the working parts before you commit.